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Carolinas Cash Adventure 2011. Cash Forecasting Versus Predictive Modeling. Treasury Management. May 17, 2011. Craig S. (“Sandy”) Saxer Senior Vice President PNC Bank. Cash Forecasting. Forecasting is a process where businesses adjust future expectations based on recent actual

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Carolinas Cash Adventure 2011

Cash Forecasting

Versus

Predictive Modeling

Treasury

Management

May 17, 2011

Craig S. (“Sandy”) Saxer

Senior Vice President

PNC Bank

cash forecasting
Cash Forecasting

Forecasting is a process where businesses adjust

future expectations based on recent actual

performance and conditions.

cash forecasting3
Cash Forecasting
  • “Show me the money…!
  • How much is reasonably achievable?
  • Lack of accuracy and predictive assessment
  • Economic instability increases demand for better cash forecasts for better executive decisions, but at the same time makes accuracy more elusive
  • Required incremental investment versus results… a slippery slope!
  • Limited treasury resources and recent events force new views of cash forecasting to include visibility and variability…
  • Hence Predictive Modeling… a method to manage around the target without having to achieve perfection, but producing a high degree of accuracy for decision-making purposes
the current state of cash forecasting
The Current State of Cash Forecasting
  • Importance of current and expected liquidity
      • Availability of short term funding, and
      • Funding costs
      • Managing internal working capital
  • Traditional Reliance on stable trading patterns and historic partner actions is suspect in the new economic climate
  • Other systemic changes have been creeping into forecasts for some time…
      • USPS first class mail delivery changes
      • Acceleration of Consumer electronic payments
      • Image Exchange
      • Card usage
      • Global business perspective
  • Most Corporate Treasuries use spreadsheets and other fragmented, non-integrated tools
  • Accounting systems focus on “book” versus “available in the bank”…
  • International balances often lack current visibility
  • Effective cash forecast horizons are limited
  • Limited treasury resources are available… 20+ years of corporate restructuring have taken their toll!!
why better cash forecasting
Why Better Cash Forecasting?
  • Focus on agility and the need to build confidence for strategic decisions
  • Best-in-Class (top 20%) cash forecasts have 36% better forecasting accuracy than laggard (bottom 30%) companies (1)
  • Top performing companies surveyed made 20% gains in profitability through better forecasting (1)
  • Identify and Control Risk
  • Dynamically account for change
  • Linking forecasts with strategic and tactical plans to provide competitive advantage

(1) Financial Planning Budgeting & Forecasting, Aberdeen Group, February 2010

treasury technology for modeling
Treasury Technology for Modeling
  • Interest in ERP and Treasury Workstations has “morphed” from cash flow accounting to visibility and improved forecasting
  • New challenges like “XBRL” and International Financial Accounting Standards are increasing the demand for automation and access to information for dynamic decisioning
  • Use of Spreadsheets (90%)
  • Stand-alone applications (45%)
  • Invest in applications that provide flexibility and visibility to forecasts
  • Dynamic planning is enabled through process, organization, knowledge management, technology and performance management
  • Example vendors: Amdocs (Clarify), PeopleSoft CRM, SAS, Teradata CRM, Unica Affinium
methods of cash forecasting
Methods of Cash Forecasting
  • Direct Cash Forecast…Detailed build-up… e.g. ERP approach using automation
  • Indirect Cash Forecast… FAS 95 … work from net operating income and adjust for non-cash items
  • 80-20% Rule (Pareto’s Law)… efficiency is gained by eliminating transaction bulk for significance… D. McCann, “For Good Forecasts, Use the 80-20 Rule”, CFO.com, June, 2009
  • The “Bucket” Theory… segments cash flows by relative impact and predictability
  • Exponential Smoothing- “periodicity” … M. Hunstad, PhD “Cash Flow Forecasting” AFP Exchange, January February 2010
  • Predictive Modeling- agility
detailed build up approach
Uses ERP details that are subject to auditing and review

Historical basis

Ties to books and records

Provides details for analysis

Can be used to provide comparative analysis… forecast versus actual experience

Promotes standardization of forecasting methodology

Complex; treasury staff- intensive

Not readily adaptive in the event of changes

Reflects book, not banking system cash

Requires costly integration and external data input

Forecast Reporting is often fixed in format and information

Can not be easily programmed to “learn” from prior variances

Limited ability to vary assumptions and create scenarios

Detailed Build-Up Approach

Pro

Con

indirect cash flow accounting method
Uses reported Net Operating Income

Actual basis

Adjusts for non-cash and working capital changes

Often uses business unit input

Useful for mid- to long term planning horizons

Provides standardization of forecasting methodology

Relatively straight-forward; not treasury staff- intensive

Not readily adaptive in the event of changes

Reflects book, not banking system cash

Limited predictive value

Does not provide detail and is more difficult to roll forward

Can not be easily programmed to “learn” from prior variances

Requires assumptions

Indirect Cash Flow- Accounting Method

Pro

Con

80 20 rule approach
Focus on top 80% of cash forecast drivers

Avoid costly attempts to achieve perfection

Apply scarce treasury resources to maximum advantage

Emphasis on comparative analysis

Elimination of detail- avoid “forest for the trees” syndrome

Improve communication and participation through a simpler, more readily understood process

Less precision= less confidence

Obtaining cooperative interaction

Dependency on timely and accurate communications

Increased risk of missed trend, especially in smaller components of the business

Less suited to multiple entities

Still requires a great deal of real time data

80-20 Rule Approach

Pro

Con

the bucket theory alternative to forecasting
The “Bucket” Theory Alternative to Forecasting

A Hybrid…

Items > $50,000

Specific ID,

Tracking

Items $5-$50,000

Aggregates of

Sub groups

Items <$5,000

Statistical Smoothing

exponential smoothing periodicity
Exponential Smoothing- Periodicity

Final

Forecast

Periodic

Components

Raw Cash

Flow data

Forecast of

Residential

Components

Residential

Components

Source: M. Hunstad, PhD “Cash Flow Forecasting” AFP Exchange, January February 2010

adding to the complexities
Adding to the Complexities
  • Policy Issues of Greatest Concern
  • Sources: Estimates based on Various News and Articles
the case for predictive modeling
The Case for Predictive Modeling
  • Market volatility creates the need to dynamically account for change
  • More decision-makers must be involved in the process
  • Ability to re-forecast as conditions move
  • Capability to perform “what-if” scenarios
  • Gaining the planning process involvement of those accountable for the delivery of performance
  • Communication and integration of forecasts with budgets and other plans
  • Ability to model impacts of assumptions made
  • Development of “best” and “worse” case alternatives
perspective components of forecasting
Perspective: Components of Forecasting

Information

Sources and uses

Direct data and its use

Model Data- assumptions and validation

People

Roles and problems

Automation

What it does well

What it does not do well

Degree of accuracy desired versus required- expectations!

Liquidity, Liquidity

Achieving a balanced approach:

Best

Expected

Worst

build your effective cash forecasting process
Build Your Effective Cash Forecasting Process
  • Understand the uses and Users of your forecasts
  • Identify and dedicate resources to your cash forecasting process
  • Identify enterprise cash flows and who manages them
  • Schedule known, non-daily cash flows (e.g. maturities, payroll, tax settlements, etc)
  • Establish control over outflows… making prediction a “reality”
  • Perform Regular variance analysis
  • Use weighting as a form of “smoothing”
  • Forecasting Agility… use assumptions with dynamic qualities to adjust and change quickly
  • Manage data around an accuracy target- set expectations of reasonable accuracy among the users of the forecast
  • Simplify structural components affecting your forecasts
summary
Summary
  • Working capital management is a vital and growing aspect of Treasury
  • Liquidity and counterparty risk assessment are wide-spread terms now – what plans has your treasury function for this?
  • Determine what will change your forecasts as well as what drives your forecast
  • Prepare “Best” and “Worst” case scenarios in addition to the “Norm”
  • Be sure to perform periodic comparative analysis… and “stress test” your assumptions!
  • Tighter Cash Forecasting is the buzz… perhaps we should more carefully consider the strategic notions linking data analysis and scenario modeling for the future… hence Predictive Modeling!
questions
Questions?

PNC Financial Services Group